Posted
by
timothy
on Thursday March 03, 2011 @11:03PM
from the race-to-the-bottom-yowza dept.

pbahra writes "One complaint made of the modern stock market is that it is concerned too much on the short term. A second is a long time in cash-equities trading. Four or five years ago, trading firms started to talk of trading speeds in terms of milliseconds. But in recent weeks trading geeks have started to talk about picoseconds, in what is a truly mind-boggling concept: a picosecond is one trillionth of a second. Put another way, a picosecond is to one second what one second is to 31,700 years."

To put this in perspective:---A picosecond is roughly "330 picoseconds (approximately) – the time it takes a common 3.0 GHz computer CPU to add two integers" (source [wikipedia.org])---To put that in perspective, since obviously a large large amount of data must be inputted and then "processed" in real time, but then they are concerned with ~350 cpu cycles?---Even if a processor can do tons of these operations a second, the amount of data they are receiving must be ghastly!Makes me think of the patriot missile system and the round-off error tragedy that occurred. I am just hoping our market does not "experience the same fate". (I do understand it was all a fundamental bad programming situation before, but decisions that are made in picoseconds should be taken with some level of precaution.)

Actually, I think we can draw a line. It takes about 200ms for an electrical pulse to travel round the world (speed of light in glass is lower than c), and we have a bit of switching delay. So this should imply the minimum timing limit. Anyway, fortunately the exchange can set the rules here, if it wants to.

And you also don't understand how deep this goes. This is not about trading fast. They are actually trading ahead of trade execution.

Flash trading is a practice in which some equity exchanges hold orders to buy and sell shares for a split second before making that information public (available to other exchanges). The exchanges' customers can view these prices ahead of other traders for a fee. High-speed computer software can take advantage of that brief period between when an order is placed and when it's executed to allow those members to potentially get better prices and profits by slipping in and making the trade themselves.

Now, the time window is about 50-300ms that the orders to be executed are posted and the automated systems can intervene. Basically, if you have orders like following coming in within 200ms (1/5 of a second),

PUT 1000@31PUT 500@30PUT 500@30.1CALL 1000@marketCALL 100@29.5

the flash orders will come in, buy the two sell orders and sell it @ 31 to the market order and you end up with,

PUT 1000@31CALL 100@29.5

This effectively stole $950 from the market order. But then they will pay 2x the trade fees to the exchange to split in their trades ahead of the others. This isn't about "testing" the market, but simply going right in the middle between transactions and milking them for the most they can. It is not trading - it is stealing.

That's one of the arguments used by HF traders to justify their trade: they claim to provide liquidity to the market. Yes, this is true; however, HF trading violates one fundamental precept of the stock market that makes it work: that market forces determines the actual value of stock, based on an assessment of the value a company provides. There is no such valuation in HF algorithms (the concept of "value" is meaningless to a computer), only arbitrage. HF trading can and often does distort true market values. They can also cause a huge mess very quickly (as witnessed in recent years i.e. the Dow dropping a 1000 points in a very short time due to a chain reaction caused by algorithmic trades).

The ideal function of a stock market in an economy is primarily to raise capital so that wealth creation activities can occur. But because of human greed, a part of it will always merely function as a wealth distribution scheme. This is okay so long as the wealth creation activities are not impeded by the wealth distribution activities. HF trading shifts the balance toward the latter, and at some point, it can actually become a detriment to the economy.

Man, there is so much misinformation in this thread, I could spend the whole day here.

HFT guys aren't stealing money from you- they are actually stealing money from the guys who have been ripping you off for decades- the exchanges, the market makers, the brokers, and everyone else in between.

Think about it- E-Trade and the like have brought down the cost of trading to about $9 a share (there is also the cost of the bid/ask spread, but we will leave that out for now, especially since these days its almost disappeared). How many other businesses do you know that can get away with a $9 transaction fee? Can you imagine going to a garage sale, buying a box of books, and having the seller say "ok that will be $5 + a $9 transaction fee?" That $9 fee is going to all the guys I mentioned above. Not too long ago, that fee was more like $50. But what's even worse is, and this is where HFT comes in, is that when you saw the stock ticker, and saw IBM trading at $80, you could neither buy nor sell that stock for $80. At best, you could buy that stock for $80.08 and sell it for $79.92, though it was just as likely to be 80.25 and 79.75. That "spread" went to a guy called the market maker. The market maker is the guy you actually buy and sell to, you don't directly buy and sell with other people (in our garage sale example, the seller would just bring his stuff to market, and the market maker would buy it off him, and then sell the stuff to you). When you watch movies showing the stock exchange, and everyone is yelling buy and sell, they are actually yelling at the guys in the middle of the floor- the market makers. The market maker collected that spread. In exchange for that privilege, he had some responsibilities- to always buy your stock, no matter if no one else wanted it.

Anyway, for decades this was a very lucrative business. Partially because market structure made the spreads so wide, and partially because it was so easy for these guys to front run, and also the chummy nature of these groups lead to a lot of gentleman's agreements where everyone kind of agreed to not step on each other's toes too often. Then came electronic trading, and subsequently decimalization. The HFT guys came in and just started spiking the volume in the markets, and also acting as market makers themselves to an extent. This has tightened spreads to the point where if you see an $80 print on IBM, you can almost certainly buy it for $80.01 and sell it for $79.99. The result of this means that any "manual" (not electronic) market maker has been wiped out or moved to automated quoting systems. They are tightening the spreads and taking money from the MM's and in some cases side stepping the brokers, and keeping the profit for themselves.

So no, they aren't stealing from Joe Retail trader in any way. If anything, they are helping you- you don't get ripped off when you sell your 50 shares of IBM anymore. Your broker and the market makers are the ones who are being stolen from- market making is now a highly competitive difficult business, and brokers are staying alive mostly by internalizing flow (and the smaller guys who can't do that are scrambling right now, and will have to consolidate).